What exactly does 'considerable time' mean? Markets are hoping that tonight’s US Federal Reserve board’s Open Market Committee meeting will provide some hints.
Over the past week and a half, markets have become more volatile and the US dollar has strengthened markedly as the meeting has neared.
While the meeting is expected to confirm that the Fed’s unconventional six-year program of bond and mortgage purchases will end next month, the markets’ focus is on what the committee says (if anything) about the timing of the first move towards 'normalising' US official interest rates from their current negligible levels.
For six months, the Fed has said that, after its quantitative easing program ends in October, official rates would stay low "for a considerable time". That has generated a guessing game as to when that moment might arrive, with most analysts speculating a protracted cycle of raising rates will begin around the middle of next year.
More recently, there has been some thought that the moment might arrive a little earlier if the US economic recovery continues to gather momentum. According to the OECD ‘s latest economic assessment, the modest growth the US is now experiencing is expected to strengthen next year, with US GDP growth forecast at 3.1 per cent.
The spike in the US dollar over the past 10 days or so would suggest that the markets are already in moving in anticipation of that first rate rise. The Australia dollar, for instance, has fallen nearly US4 cents in a week and a half.
What the stronger dollar appears to reflect is a shift in capital flows out of the US into markets and assets offering positive returns back in to the US, where commercial interest rates have already begun strengthening. The currency relativities both reflect that shift and help promote it, given that US investors with offshore exposures face currency losses if the US dollar continues to strengthen.
The OECD commentary overnight made exactly that point, saying that the anticipated tightening of US monetary policy could lead to shifts in international financial flows and sharp exchange rate movements that would be "disruptive", especially for some emerging market economies. It also said the bullishness of financial markets appeared at odds with the intensification of several risks.
One of those risks is the withdrawal of cheap liquidity that has underpinned asset prices around the globe as the Fed normalises rates. The opacity of global financial markets makes it difficult to determine how big the various carry trades underpinned by access to cheap US credit might be, but the extent of the movements in currencies suggests the extent of the activity is substantial.
As they are unwound, the potential knock-on effects on markets and asset prices could be very significant and markets would also be likely to become more volatile.
From a parochial perspective, it wouldn’t be all bad news.
The traditional close relationship between commodity prices and the Australian dollar had broken down until very recently, with the dollar refusing to fall in line with the declines in key commodity prices. In the past 10 days, as the iron ore price has plummeted and the US dollar strengthened, the correlation has been more pronounced.
While the impact on both the resource sector and the rest of the economy so far has been relatively modest, it is helpful.
While companies like Rio Tinto and BHP Billiton and their smaller peers might be more exposed to iron ore prices than currency, with a large slab of their costs in Australian dollars but their revenues in US dollars, a depreciating Australian dollar helps to blunt the impact of the commodity price falls.
BHP, for instance, 'loses' $US135 million for every $US1 a tonne fall in the iron ore price (its earnings are most sensitive to iron ore prices) but 'gains' $US100m for US1 cent fall in the Australian dollar.
For the non-resource sectors, of course, it makes exports more competitive and imports less competitive.
The Australian dollar is still well short of where the Reserve Bank and others would like it to be. But, if the OECD is right and markets haven’t fully factored in the impact of the looming change in US monetary policy, there are further falls in the dollar to go.
Markets tend to overshoot in both directions, so it is quite feasible that when the dollar properly cracks it will come back to earth with a thud, which wouldn’t be a bad thing.
Whatever happens overnight, the next six to 12 months is going to be dominated by discussion about the Fed’s future actions, the timing of the first rise in US official rates and then the pace at which the US rate structure is normalised.
The change in stance could (and almost certainly will) have some unintended and unforeseen consequences for the rest of the world, with the still weak eurozone and emerging economies probably the most vulnerable.